CFA Level I Exam · Introduction to Equity Valuation

Equity Valuation Process and the Analyst's Role

Q: What are the steps in the equity valuation process?

The steps are understanding the business, forecasting company performance, selecting an appropriate valuation model, converting forecasts into a valuation, and applying the valuation conclusion. The last step includes making recommendations and communicating results. Learn them in this order.

Q: How do I understand a business for equity valuation?

Study the industry, the company's competitive position, its business model, and the quality of management and governance. Tools such as Porter's five forces and the industry life cycle help. This step is descriptive and comes before any forecasts.

Q: How does Porter's five forces apply to valuation?

It shows how much profit an industry can sustain. Strong entry threat, substitutes, supplier power, buyer power or rivalry lower margins and pricing power. Those views then feed your revenue and margin forecasts.

Q: What is the analyst's role in valuation?

The analyst builds forecasts, picks a suitable model, estimates value, and communicates a conclusion. The analyst must have a reasonable basis, state assumptions and risks, and present results fairly and without misleading the reader.

Updated 7 October 2026 · Fact-checked

The equity valuation process has five steps: understand the business, forecast company performance, select the right valuation model, convert forecasts into a value, and apply the valuation in a recommendation. Analysts must also communicate results clearly, with a sound basis, and in line with ethical standards.

Understand Valuation Process and Analyst Role

Equity valuation estimates what a share is worth, called intrinsic value. You then compare it with the market price. If value is above price, the stock may be undervalued. If value is below price, it may be overvalued. Valuation is a process, not a single calculation.

The process runs in order. First, understand the business. This covers the industry, the competitive position, the business model, and the quality of management and governance. Second, forecast company performance. You project sales, margins, cash flows and growth, using past results and your view of the industry. Third, select an appropriate valuation model. The model must fit the company and the data you have. Fourth, convert the forecasts into a valuation. You run the model and often use scenario or sensitivity analysis. Fifth, apply the valuation conclusion. This means making a recommendation, often in a research report.

Industry analysis sits inside step one. Porter's five forces is the classic tool: threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitutes, and rivalry among existing competitors. Strong forces reduce profit potential and pricing power. Weak forces support higher and more stable margins. You also look at the industry life cycle and whether the sector is cyclical.

The analyst's role goes beyond running numbers. Analysts must have a reasonable basis for conclusions, separate fact from opinion, state assumptions and risks, and present results fairly. The value is only as good as the inputs. Weak forecasts give weak valuations, however polished the model is.

On the exam, questions test the order of the steps, which activity belongs in which step, and which analyst behaviour is appropriate. Read each stem for the activity described and match it to a step.

Key formulas to remember

Five steps of the valuation process: Understand business → Forecast performance → Select model → Convert forecasts to valuation → Apply valuation (recommend/communicate); Learn the order. Many questions ask which step an activity belongs to.
Porter's five forces: New entrants, supplier power, buyer power, substitutes, rivalry among existing competitors; Stronger forces mean lower industry profit potential and weaker pricing power.
Value versus price decision: Intrinsic value > market price → undervalued; intrinsic value < market price → overvalued; Holds for your estimate of value. The conclusion is only as reliable as your inputs.

How to solve Valuation Process and Analyst Role questions

Use this method for any question on the valuation process or analyst role.

1Read the stem and underline the activity being described, such as studying competitors, projecting sales, or choosing a model.
2Map the activity to one of the five steps: understand the business, forecast, select model, value, apply.
3If the question asks about industry structure, list the five forces and decide whether each is strong or weak.
4Judge the effect: strong forces lower profit potential and pricing power; weak forces raise them.
5For analyst-role questions, check for a reasonable basis, clear communication of assumptions and risks, and fair presentation.
6Remove the two options that mismatch the step or conflict with these principles, then choose the remaining one.

Quickest way: Match the activity to the step

When to use it: Use when the question names a task and asks where it fits in the process, or which action is most appropriate.

Say the five steps in order in your head.
Spot the verb in the stem: study, forecast, choose, compute, recommend.
Pick the step that verb matches.
Eliminate options that reverse the order, such as choosing a model before understanding the business.
If two options remain, prefer the one that gives a reasonable basis and states assumptions and risks.

Common mistakes in Valuation Process and Analyst Role

Putting model selection before understanding the business.
Students think valuation is mostly about formulas.
Fix: Remember the model must fit the business, so business understanding and forecasting come first.
Treating forecasting as part of understanding the business.
Both use industry and company data, so they feel alike.
Fix: Understanding is qualitative and descriptive. Forecasting turns that understanding into projected numbers.
Reading strong Porter forces as good for profits.
The word 'strong' sounds positive.
Fix: Strong supplier power, buyer power, rivalry, substitutes or entry threat all hurt industry profitability.
Assuming a precise valuation output is reliable.
A model gives a single clean number.
Fix: Remember value depends on inputs. Use scenarios and sensitivity analysis and state the risks.
Thinking the process ends once a value is computed.
The calculation feels like the finish line.
Fix: The last step is applying the result, such as a recommendation with clear communication of assumptions and risks.

Worked examples

Example 1

An analyst reviews a global beverage firm's market position, supplier relationships and management quality before building any projections. Which step of the valuation process is she performing?

A. Understanding the business
B. Forecasting company performance
C. Selecting an appropriate valuation model

Show the solution

The activity is reviewing market position, suppliers and management. No projections are built yet.
Describing the business and its environment is the first step.
Forecasting needs projected numbers, which she has not started. Model selection comes after forecasting.

Answer: A. Understanding the business

Example 2

A software industry has low barriers to entry, many close substitutes and powerful corporate buyers who can switch easily. Which conclusion is most consistent with Porter's five forces?

A. Industry profit potential is likely to be low
B. Industry profit potential is likely to be high
C. Industry pricing power is likely to be high

Show the solution

Low barriers to entry means a strong threat of new entrants.
Many close substitutes means a strong threat of substitutes.
Powerful, switching buyers means strong buyer bargaining power.
Three strong forces compress margins and weaken pricing power, so profit potential is low. This rules out B and C.

Answer: A. Industry profit potential is likely to be low

Exam tips

Memorise the five steps in order. Many items only test sequence and classification.
Match the verb in the stem to a step before reading the options.
For Porter's forces, ask whether the force is strong or weak, then link strong to lower profits.
On analyst-role items, favour options with a reasonable basis, clear assumptions and fair communication of risks.
With no penalty for wrong answers, always answer. Eliminate options that break the order of steps first.

Practice questions from Introduction to Equity Valuation

Valuation Process and Analyst Role in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Valuation Process and Analyst Role: frequently asked questions

What are the steps in the equity valuation process?

The steps are understanding the business, forecasting company performance, selecting an appropriate valuation model, converting forecasts into a valuation, and applying the valuation conclusion. The last step includes making recommendations and communicating results. Learn them in this order.

How do I understand a business for equity valuation?

Study the industry, the company's competitive position, its business model, and the quality of management and governance. Tools such as Porter's five forces and the industry life cycle help. This step is descriptive and comes before any forecasts.

How does Porter's five forces apply to valuation?

It shows how much profit an industry can sustain. Strong entry threat, substitutes, supplier power, buyer power or rivalry lower margins and pricing power. Those views then feed your revenue and margin forecasts.

What is the analyst's role in valuation?

The analyst builds forecasts, picks a suitable model, estimates value, and communicates a conclusion. The analyst must have a reasonable basis, state assumptions and risks, and present results fairly and without misleading the reader.